On balance, yuan liquidity pools are still far out of sight

Thursday, 07 October, 2010, 12:00am

with Jake van der Kamp

At a luncheon speech yesterday, Li said the critical requirement for yuan IPOs was the creation of a yuan liquidity pool in the city that could then be invested in yuan bonds and yuan shares issued in Hong Kong.

SCMP, October 6

I went along to listen to HKEx chief executive Charles Li Xiaojia make this speech at the Foreign Correspondents Club. He recently wrote a 10,000-word proposal on his yuan trading idea and many influential people have sagely nodded in agreement.

One thing that struck me early on in his remarks, however, is that he was certainly right when he said he is no economist. His subject matter was really the balance of payments and it was quickly apparent that he does not really understand it.

But perhaps he addressed this point when he told his audience that whilst he could explain his views in Chinese he could only summarise them in English. As he is a fluent English speaker, one must assume that the deficiency lies in the English language relative to the Chinese one.

This perhaps also explains why he said that his Chinese audiences mostly agree with him while his Western ones are sceptical.

Charles, a word to the wise here. These sorts of race-sensitive remarks generally come under the heading of Not Really Helpful.

Nonetheless, I have to confess that I came away still not able to grasp just what it is he actually wants to do. At some ultimate level it is clearly to make HKEx a dominant trading centre of yuan financial instruments in a world (or at least a Hong Kong) in which the yuan is a free floating currency and all restrictions on it have been removed. This is a stock exchange idea of heaven. It would certainly make Li's career soar.

But ... hmmm ... yes, we're not quite there. The mainland's capital account remains firmly closed and the yuan a rigged currency, which is entirely understandable. Opening the capital account is about the most democratic thing Beijing could do short of introducing the ballot box. It would hugely undermine the authority of the central government.

Li is a realist. He knows it. He can talk high, and he does, but he has to aim low, much lower than he talks, and this does not amount to much more than crossing his fingers that Beijing will soon allow HKEx a yuan-denominated initial public offering.

It could happen next year, he told his audience. Given that next year is less than three months away, this drew the obvious question. But he wouldn't be drawn. Next year and don't ask what month.

Then comes the big problem, the creation of that yuan liquidity pool in Hong Kong. Without this it's pointless to have a yuan-denominated stock. People won't have the yuan to buy it.

We do have about 100 billion yuan (HK$115.77 billion) deposited in Hong Kong and this figure is rising fast, which is no surprise given the very strong likelihood of continuing yuan strength and the fact that these yuan deposits actually pay you interest, unlike Hong Kong dollar deposits.

Most of this money, however, is at work across the border rather than in Hong Kong. We just don't have much in yuan-denominated businesses here. Thus it does not really constitute a pool of yuan liquidity and might not be enough for a heavily oversubscribed IPO.

And that's where Li starts scratching his head, talking about the central government making money available (and my name is Rumpelstiltskin) or tapping foreign direct investment flows (get your hand on that tap first, Charles) and otherwise giving voice to confused thoughts.

He spoke, for instance, of using yuan from trade account inflows, utterly ignoring that China's net trade receipts are all in US dollar or other foreign currencies, not yuan.

It is indeed conceivable that his pools of yuan might one day be available outside of China's border but only under a scenario in which the mainland runs a consistent trade deficit or investment outflows far exceed investment inflows.

At the moment both of these scenarios are far out of sight and becoming more so. As the chart shows, both current and capital account have been in positive territory for almost 10 years and together now show a surplus of almost US$400 billion a year.

That's the long and short of the balance of payments, Charles. Look it up some day in a basic economics book.